This letter presents the comments of Federated Investors, Inc. ("Federated") regarding several proposals of the Securities and Exchange Commission ("Commission") to implement the requirements of §§ 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "2002 Act"). These proposals1 include:

Required disclosure regarding the adoption of a Code of Ethics for senior financial officers, and any changes to or waivers of such Code of Ethics (the "Code of Ethics Proposal");

Proposed changes to the certifications required from a company's principal executive and financial officers under § 302 of the 2002 Act.

Federated is commenting on these proposals both in its capacity as a company listed on the New York Stock Exchange (the "NYSE") which files reports under §13(a) of the Securities Exchange Act of 1934 (the "1934 Act") and as one of the largest asset management and mutual fund firms in the United States.2

At the outset, Federated would like to express its unqualified support for the comments made by the Investment Company Institute in its letter on these proposals (the "ICI Letter"). In addition to these comments, however, Federated would like to address several key issues separately. First, Federated cannot find any basis for expanding the Code of Ethics requirements beyond those mandated by § 406 of the 2002 Act. Second, Federated recommends that the Commission take affirmative steps to protect audit committee members designated as "financial experts" from undue risks. Finally, Federated urges the Commission to leave the §302 certification requirements alone until companies have finished implementing their procedures.

The Code of Ethics Proposal

Section 406 of the 2002 Act mandates that the Commission adopt regulations requiring companies subject to the reporting requirements of §13(a) or 15(d) of the 1934 Act ("reporting companies") to disclose whether the company has adopted a code of ethics for its senior financial officers. The senior financial officers covered by the code of ethics must include the reporting company's principal financial officer, principal accounting officer or controller, or persons performing similar functions. Under § 406, a code of ethics must promote:

Honest and ethical conduct, including the ethical handling of conflicts of interest;

The Code of Ethics Proposal would expand these requirements in several respects. First, the Code of Ethics Proposal would expand the compass of senior financial officers to include the principal executive officer. Second, in the case of investment companies, the Code of Ethics Proposal would extend the reach of § 406 beyond the issuer to also require disclosure regarding whether the investment company's investment adviser and principal underwriter3 have adopted Codes of Ethics for their respective senior officers. Finally, the Code of Ethics Proposal adds three additional elements to the mandated code of ethics.

Federated questions the need to impose requirements for a code of ethics beyond those mandated by § 406. While we would agree that any company should take reasonable measures to assure that its employees act in an ethical and professional fashion, § 406 is not directed at this. The law focuses entirely on the public disclosure of a code of ethics (or lack thereof). Federated understands that this section, like much of the 2002 Act, is intended to restore public confidence in financial reports. Requiring public disclosure of the standards to which those responsible for preparing such reports (i.e., the senior financial officers) are held accountable is a measure reasonably tailored to this end. However, the Release does not explain why investors will require disclosure beyond that mandated by the statute to determine whether they can rely on a company's financial reports.

Federated is particularly concerned about two requirements of the Code of Ethics Proposal. The first is the requirement that an investment company must make disclosures regarding its investment adviser's and principal underwriter's codes of ethics. The second is the requirement that a code of ethics promote "avoidance of conflicts of interest." Federated believes that both of these requirements will create unnecessary complications, without furthering any significant shareholder interest.

Codes of Ethics for Investment Advisers and Principal Underwriters

The Release offers the following explanation for requiring an investment company to disclose whether its investment adviser and principal underwriter have adopted codes of ethics for their respective senior officers: "The proposed disclosure requirements would generally cover the same entities covered by Rule 17j-1 [under the Investment Company Act of 1940] ... because these are the entities with respect to which conflicts of interest and other ethical issues are most likely to arise."4 Yet, in the preceding paragraph, the Release acknowledges that the Code of Ethics Proposal "would address a broader range of conduct" than Rule 17j-1. Given the different "conflicts of interest and ethical issues" addressed by Rule 17j-1 and the Code of Ethics Proposal, it is not self-evident that they should "cover the same entities."

More importantly, both Rule 17j-1 and the Code of Ethic Proposal apply to the conduct of individuals, not entities. The code of ethics mandated by Rule 17j-1 governs the conduct of Access Persons, as defined in the rule. The code addresses conflicts of interest and ethical issues that arise in connection with the personal trading of these individuals, not the investment adviser or principal underwriter. Presumably, the reason Rule 17j-1 requires these entities to adopt codes of ethics is that they are likely to employ Access Persons.

In contrast, the code of ethics covered by the Code of Ethics Proposal would regulate the general conduct of senior financial officers of the investment adviser and principal underwriter who may have nothing to do with the investment company. These officers are no more likely to be involved in an investment company's operations than the senior financial officers of other fund service providers, such as its auditor, custodian or transfer agent. Therefore, the senior financial officers of the investment adviser and principal underwriter are no more likely to have "conflicts of interest or ethic issues" with regard to an investment company than a host of other individuals for whom the Code of Ethics Proposal would not require disclosure of a code of ethics.

In fact, adoption of a code of ethics for the investment adviser's and principal underwriter's senior financial officers will do nothing to protect investment company shareholders. Federated's principal financial officer and principal accounting officer have nothing to do with the preparation of financial reports for, or operations of, our mutual funds. They are not officers or directors of our mutual funds. Their interactions with the mutual funds are entirely in their capacity as employees of the investment adviser and principal underwriter. In this capacity, they normally should not have any personal conflicts of interest with our investment companies.

Consequently, any code of ethics adopted by Federated for our senior financial officers will regulate only their relationship with Federated, not the mutual funds or their shareholders.5 It will address conflicts of interest between an officer and Federated, not between the officer and the mutual funds. It will address disclosure in reports filed by Federated, not the mutual funds. It will address regulatory compliance by Federated, not the mutual funds. As a result, it only will serve to protect Federated, not the mutual funds. We cannot understand how disclosure of such a code of ethics could possibly be of interest to mutual fund investors.

Avoidance of Conflicts of Interest by Senior Financial Officers

As mandated by § 406, clause (a) of the definition of a "code of ethics" under the Code of Ethics Proposal would require "the ethical handling of actual or apparent conflicts of interest." In addition, the Commission is proposing to extend §406 by adding clause (b) of the definition to also require "[a]voidance of conflicts of interest, including disclosure to an appropriate person or persons identified in the code of any material transaction or relationship that reasonably could be expected to give rise to such a conflict." The Commission intends clause (b) to "supplement the requirements specified by section 406."6 Federated is concerned that the new clause could be understood to require senior financial officers to avoid conflicts of interest altogether, rather than simply disclosing them. As explained in the ICI Letter, at least with respect to investment companies, this would be asking those officers to do the impossible; with respect to other issuers, it is simply unnecessary.

We do not believe that the Commission intends this result. In explaining this requirement, the Release notes that "[a] comprehensive code of ethics should set forth guidelines requiring avoidance of conflicts of interests and material transactions or relationships involving potential conflicts of interests without proper approval."7 Clearly, the Commission intends for a code of ethics to require senior financial officers to obtain "proper approval" when a conflict arises. However, the Code of Ethics Proposal omits the words "without proper approval" from clause (b) of the proposed definition.

The Commission does not need to add clause (b) to the definition to assure that a code of ethics promotes disclosure of conflicts of interest. Clause (a) already requires a code to promote "the ethical handling of actual or apparent conflicts of interest." If the Commission believes it is necessary to explain that this includes disclosure of the conflict, it could do so by appending "including disclosure of such conflicts to an appropriate person or persons identified in the code" at the end of clause (a). There is simply no need to use the terms "avoid" or "avoidance," which can only obscure the Commission's intended meaning.

The Financial Expert Proposal

It is difficult to offer constructive comments to rules mandated by a statute as poorly conceived as § 407 of the 2002 Act. The Release does an excellent job of contrasting § 407 with the recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the "Blue Ribbon Committee") and the proposals of various SROs. The Blue Ribbon Committee and the SROs, recognizing that "[w]ithout some level of financial competence, members of an audit committee may be unable to adequately perform their vital corporate duties," call upon listed companies to include on their audit committees "members with accounting and/or related financial expertise."8 Federated does not foresee any difficulties in complying with the Blue Ribbon Committee's recommendation. Federated's audit committee includes two Certified Public Accountants, one a current chief financial officer and the other a former vice president of finance. The audit committee for Federated's investment companies includes three former partners of major public accounting firms, one of whom is a former chief financial officer and business school professor.

In contrast, § 407 mandates rules requiring reporting companies to disclose whether members of their audit committees have been designated "financial experts," who will "serve as a resource for the audit committee as a whole in carrying out its functions."9 The inherent flaw in this approach is that it will inevitably create divisions between those designated as "financial experts" and the rest of the audit committee and the board. In the heat of litigation, it is likely that someone will attempt to exploit this division to the detriment of the "financial expert(s)" and/or the other members of the board. While it is comforting that the Commission does not intend to "impose a higher degree of individual responsibility or obligation upon a member of the audit committee ... [or to] ... decrease the duties and obligations of other audit committee members or the board of directors,"10 the harsh reality is that judges of the various state and federal courts, rather than the Commission, will control these decisions. As importantly, neither the Commission nor the courts can keep class-action plaintiffs from targeting the "financial expert" members of the audit committee and subjecting them to prolonged depositions and discovery.

Ideally, assuming that Congress intended to encourage reporting companies to include "financial experts" on their audit committees, Congress would have included some protection for them in the 2002 Act. Without a federal law preventing courts from "imposing a higher degree of individual responsibility or obligation" on audit committee members designated as "financial experts," we would not expect many audit committee members to willingly accept the designation. In addition, just one decision imposing a different standard of liability on a designated "financial expert" could jeopardize the availability of insurance for the designated directors. Without insurance, it would be unreasonable to expect anyone to agree to designation as a "financial expert."

Federated realizes that the Commission cannot protect designated "financial experts" to the same extent as Congress. However, the Commission does have authority to regulate its enforcement activities, and your position may be viewed with deference by courts when they consider the import of the "financial expert" designation. Therefore, if the Commission desires to see reporting companies include and designate financial experts on their audit committees, it is paramount that the final regulations include language to the following effect:

No member of an audit committee designated as a "financial expert" in any registration statement or report filed with the Commission shall be:

(a) considered an "expert" for purposes of section 11 of the Securities Act of 1933, or

(b) required to exercise a higher standard of care, undertake any higher degree of individual responsibility or assume any additional obligations with respect to any registration statement, report or other document filed with the Commission,

solely as a result of his or her designation as a financial expert on such audit committee.

Ideally, the Commission would incorporate this language in a separate rule. The second best approach would be to include it as an instruction in Regulation S-K and each other rule that deals with "financial expert" disclosure. Simply discussing the Commission's position in the adopting release will not have the desired effect. Without a formal, well-publicized position on this issue, audit committees cannot rely on courts to take notice of, or refrain from speculating as to possible changes in, the Commission's views.

Changes to the § 302 Certificate

The Commission has already adopted regulations that are more than compliant with the certification requirements of § 302 of the 2002 Act. The Commission has also proposed a new form (to be designated N-CSR) for such certifications by the principal executive and financial officers of investment companies.11 Federated's comment letter on the N-CSR proposal detailed the tremendous burdens that § 302 has imposed on companies, particularly investment companies. Federated does not believe that there is any reason to add to these burdens at this time.

The Release states that the proposed changes to the § 302 certificate are intended to:

Provide a basis for [the] quarterly disclosure about changes to the company's internal controls and procedures for financial reporting, and to create symmetry between our requirements for periodic evaluations of both the company's disclosure controls and procedures and its internal controls and procedures for financial reporting ....12

The first rationale presupposes that a company will have changed its internal controls and procedures. However, this will not be the case for most companies for most quarters. There is simply no need to provide "a basis" for what in all likelihood will be negative disclosure about changes in internal controls and procedures.

The second rationale presupposes: (a) a need for symmetry between disclosure controls and procedures and internal controls and procedures, and (b) that the Commission should establish this symmetry by increasing the frequency of evaluation of internal controls and procedures, rather than reducing the frequency of evaluation of disclosure controls and procedures. However, the 2002 Act already deals separately with the evaluation of internal controls and procedures (in § 404) and the certification of changes in internal controls and procedures (in § 302). Clearly, Congress did not perceive any need for symmetry on this issue. Moreover, as detailed in Federated's comment letter on the N-CSR proposal, based on our experience with the certification process over the past three months, we doubt that shareholders will benefit at all from evaluations of disclosure controls and procedures conducted more frequently than annually. While we realize that § 302 requires that certifying officers perform evaluations within 90 days of the filing, Federated contends that this requirement was ill advised, and should not be expanded beyond the literal requirements of the 2002 Act.

Fundamentally, the Commission needs to understand, as Federated emphasized in its previous comment letter, that reporting companies have already expended considerable time and effort in developing and implementing new processes to satisfy the requirements of § 302. Each quarter (or month in the case of large investment company complexes) these companies are confronting new questions and refining their processes. It would lighten our regulatory burdens immensely if the Commission would leave the § 302 certificate alone until the reporting companies have had an opportunity to assimilate fully to the new certification process. Federated therefore urges the Commission to refrain from modifying the certificate requirements until there is a compelling reason to do so.

* * * * *

In conclusion, Federated urges the Commission to remain circumspect in expanding the regulatory burdens on reporting companies beyond those specifically mandated by the 2002 Act. While we would not stint at any measure reasonably designed to enhance investor confidence in the markets, financial reporting or investment companies, we expect that some of the changes wrought in the 2002 Act will do little to further this laudable goal. We therefore ask the Commission to exercise a healthy skepticism as to whether additional regulations will realistically further the objectives of the 2002 Act.

Federated very much appreciates having the opportunity to comment on these proposals. If you would like to discuss these comments with us, please contact the undersigned by phone at (412) 288-1567 or by e-mail at skeen@federatedinv.com. Thank you very much.

Through its subsidiaries, Federated manages total assets of more than $175 billion and serves as adviser, subadviser, distributor, and/or administrator for over 280 mutual funds, as of September 30, 2002.

The Code of Ethics Proposal would only require disclosure regarding the principal underwriter's code of ethics if the principal underwriter is an affiliated person of the investment adviser or shares a common officer, director or general partner with the investment adviser.

We assume that the Commission did not intend to require that Federated adopt two separate codes of ethics, one regulating the senior financial officers' relationship with Federated and another regulating their relationship with its mutual funds. As noted above, a second code of ethics would be meaningless, since these senior financial officers do not enter into transactions, review or prepare disclosure filings or monitor compliance on behalf of the mutual funds.